It’s Not About Interest Rates: Part 1

One of the most common questions asked in my travels and on the lecture circuit is the direction of interest rates. Another common question is when is the best time to lock in interest rates?

First, where are interest rates headed? Watch for signals from the Federal Reserve. Their mandate is to maintain price stability and full employment. Two metrics to observe are unemployment rate and core inflation.

Full employment is considered 5% unemployment. Some question whether this should be raised to 6%. The current unemployment rate is 9.9%. If one counts discouraged workers and the underemployed as well as dislocated workers, the true rate is 17.1%. Until this rate starts to be reduced to below 8%, the Federal Reserve will be reluctant to raise interest rates.

In determining interest rate trends it is important to examine core inflation. This is the inflation measure that excludes food and energy because they are very volatile. The core inflation rate has been well under 2%, ranging from 1.3% to 1.7% recently. Until this measure is north of 2%, the Federal Reserve will be less aggressive in raising rates.

The Fed Funds rate, which the prime rate is based on, has averaged 4.68% since World War II. With the current Fed Funds rate at less than 25 basis points, one can assume interest rates will rise. As a rule of thumb, if one takes the Fed Funds rate and adds 3%, that will generally be the prime rate.

Regardless of where interest rates are going, to an individual borrower it is not about rates. Check out next week’s article for an explanation.

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.